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Why the Solar Industry Is Its Own Worst Enemy

Growth in the solar industry may be what kills its biggest subsidy.

The U.S. solar industry's growth over the past five years is nothing short of amazing. In 2009, 382 megawatts of solar were installed in the U.S. and in 2014 that figure had grown 1,500% to 6,201 megawatts.

Image source: GTM Research 2014 Solar Insights Report.

Companies like SolarCity(NASDAQ:SCTY.DL), Vivint Solar(NYSE:VSLR), and SunPower(NASDAQ:SPWR) can now build and finance residential solar systems (which are even more expensive than larger systems), and they can sell them to homeowners for less than the cost of electricity from the utility.

All of this growth is great and it has been a great two-year run for solar investors, but there's a big cloud on the solar industry's horizon that's made worse by too much success.

Image source: SunPower.

Subsidies and solar The solar industry has long been assisted by subsidies, which have ranged from feed-in tariffs to tax subsidies in different countries around the world. In the U.S., the 30% investment tax credit, or ITC, is the industry's largest subsidy and when combined with other tax benefits like accelerated depreciation can effectively pay for about half of a solar system's cost in the first year.

For companies like SolarCity and Vivint Solar, the expiration of the ITC could be devastating. They're not only totally reliant in the U.S. market for demand, they benefit even more than most by receiving the ITC tax benefits at a system's value, not just their cost, something that's been brought up before Congress and is being looked into by the U.S. Department of Treasury.

The question facing installers today is: With the industry growing like a weed, what reason does the government have for extending tax subsidies?

Image source: SolarCity.

Falling subsidies is a story we've seen before The U.S. isn't the first country to face this dilemma. Germany's feed-in tariff drove the growth of solar in the 2000s and had to be lowered regularly because installations would skyrocket as costs fell and investing in solar projects became more practical. Between 2008-2014, Germany's feed-in tariff rate dropped about 80% and yet the industry survived. Even in the U.S. we've seen the reduction or expiration of subsidies from New Jersey to California in recent years, yet installations continue to grow.

Even the wind industry has seen the expiration of the production tax credit, which subsidized wind electricity generation by paying plant owners for each kW-hr of energy they produced.

If the ITC falls to 10% for commercial project owners and is eliminated for homeowners, as the current law states, the industry will adapt and adjust like it has in the past. But it's ironic that the growth and financial success of the solar industry in the past few years has undercut the argument that it needs subsidy help at all. In that way, the solar industry has been its own worst enemy.

What's likely to happen There will be a lot of debate about the ITC in the next two years from both those who want to keep it and those who want it eliminated. The solar industry's growth may make it hard to keep the subsidy as it's written today, but there is some good news. The growing number of states that are building significant solar industries and employing thousands of workers in the process may make it politically possible to replace the ITC with a reduced tax credit or some other form of subsidy.

The political reality is that there's widespread support for solar around the country, so if it came down to a debate over outright elimination of the ITC it could be politically detrimental to fight extension. But it also doesn't make much economic sense for the government to subsidize an industry that can support itself without subsidies, or at least on lower subsidies.

A logical resolution would be to agree on a temporary lower subsidy like a 15% ITC for two or three years that would be phased out in exchange for consistent rules giving solar access to the grid. One of the ways utilities are fighting solar today is by challenging net metering and changing their fee structure to undercut competition from solar energy, so setting a level playing field across the country may be something the industry would accept as a compromise.

The debate will be one that has a huge impact on all solar installers in the U.S., so it's worth watching for investors. Just keep in mind that subsidies have helped fuel growth and success may be the very reason lawmakers will end subsidies for solar.